Yellow Metal: Use drop in gold prices to build portfolio

However, with economic recovery gaining pace and vaccination picking up, the uncertainty is gradually reducing, dragging down gold prices.

While equity schemes reported net outflows for eight months in a row, gold exchange traded funds (ETFs) received consistent net inflows. After reporting a net outflow of Rs 141 crore in November 2020, gold ETFs received consistent net inflows. In February, it received a net inflow of Rs 491 crore and in January, received Rs 625 crore, according to data from Association of Mutual Funds in India.

Gold ETFs are reporting net inflows despite the fall in underlying yellow metal prices. In fact, gold prices have dropped 25% from an all-time high of Rs 55, 922 per 10 grams on August 7, 2020. So, why are investors still betting on gold? And if investors have substantially higher allocation to gold, should they sell some now?

Fundamentals of gold
Gold is seen as a safe-haven asset, which investors turn to during times of increased risk aversion. Globally, gold prices rose because of the Covid-19 pandemic as investors sold stocks and invested in the metal.

However, with economic recovery gaining pace and vaccination picking up, the uncertainty is gradually reducing, dragging down gold prices.
Himanshu Srivastava, associate director, Manager-Research, Morningstar India, says gold functions as a strategic asset in an investor’s portfolio, given its ability to act as an effective diversifier and alleviate losses during tough market conditions and economic downturns. This is where it draws its safe-haven appeal.

“During the challenging investment environment over the last few years, gold emerged as one of the better performing asset classes, thus proving its effectiveness in investors’ portfolio. Expectedly, this has attracted investors’ interest. Now with gold coming off its all-time highs touched in August last year has provided a good buying opportunity to investors, which resulted in net inflow for the category in February,” he says.

Should you buy now?
A correction in gold prices can be ideal to buy the metal. One should allocate up to 15% of the total portfolio in gold and long-term investors should not worry much about short-term volatility in gold prices. While most Indians prefer to invest in the precious metal in the physical form, gold ETFs of mutual funds are an efficient way to invest in the precious metal.

Chirag Mehta, senior fund manager, Alternative Investments, Quantum AMC, says gold’s arch rivals —the US dollar and US bond yields— have been strengthening off late, hurting the yellow metal. However, this trend will be short-lived. “The macro-economic environment of low interest rates, a weakening dollar, growing inflationary pressure, debt accumulation and monetary expansion warrants an allocation to gold which remains an effective portfolio diversifier and counterweight to paper money. Investors should definitely use this correction in gold prices to build their allocation,” he says. Mehta further explains that in spite of the recent uptick in yields, real interest rates still remain at historically low levels. Given that the road to economic recovery and herd immunity is a long one, the Federal Reserve has repeatedly denied any tapering in its bond buying or hike in interest rates any time soon.

“Though the central bank has so far chosen to anchor short term rates and let market forces determine the equilibrium on the long end, it is possible that going forward it may opt for yield curve control and impose interest rate caps on longer maturity bonds in order to avoid derailing the economic recovery. Combine that with more spending with Biden’s $1.9 trillion fiscal stimulus and expected infra splurge and you have ballooning deficits and further increase in debt which will keep the dollar under pressure. With more money trickling down to the real economy due to additional spending, the market is expecting robust inflation going forward,” Mehta says, explaining why gold prices may move up again.

While it may be a good opportunity to buy gold, should people sell some of their holdings now? While a portfolio allocation up to 15% to gold is recommended at all times, anything higher than that tends to have diminishing marginal utility in the portfolio. “A tad higher allocation to gold in these uncertain times will not be counterproductive. But those with a significantly higher allocation can wait for a rebound in prices to rebalance their portfolio, considering that current prices seem stretched to the downside given the macroeconomic fundamentals,” says Mehta.